Instantor's Blog

Alternative Credit Scoring as a Force for Good

An effective digitalisation process creates meaningful change through exciting new areas of technology. Many of the technical benefits of such a shift are apparent, such as better user experiences and faster load times. Technology is transforming economies, pushing companies to adapt and forcing governments to reconsider its implications. But what about the social benefits? What are some of the impacts of digital transformations on society?

One such area of digital transformation is around alternative credit scoring. Thanks to new ways to calculate a person’s credit score, lenders can tap into previously unused data sources to make decisions more quickly and efficiently. The benefits are enormous since these tools are a much less risky option to judge creditworthiness for credit lenders. But the most significant benefits of all may come in a form not previously considered: social benefits.

Image credit: James Pond

Access to good sources of credit is difficult for millenials

Sadly, many groups in the world struggle to access trustworthy sources of credit, and some of the affected are millennials. For example, almost 67% of young adults surveyed in the U.S. don’t have a credit card.And in the UK, the charity Citizens Advice has increased numbers of young people struggling with problems associated with high-cost credit come through their doors. There are many factors which go against young people when judging credit-worthiness which causes credit agencies to view this generation unfavourably. This vulnerable age group is suffering because of a lack of access to credit generated by bias from lenders.

One of the reasons that millennials suffer is because of age discrimination. For example, when determining eligibility, credit bureaus might ask a candidate how long they have been in their job for and use this as a measure of creditworthiness. This factor is going to count against millennials who may only have a few years of work experience or who may still be enrolled at University.

A second, significant, reason is a consequence of lifestyle habits. Young adults want to keep options open, meaning that millennials, more so than any other generation, move around a lot. As part of MoveHub’s 2017 Global Moving Trends report, almost 60% of 18 to 35-year-olds enquired about moving abroad last year. Many move to seek a different culture, higher salaries, a lower cost of living, or even just to fulfil a sense of adventure. But unfortunately, these behaviours could have an impact on an individual’s credit score. Even if a millennial moves abroad with a well-paying job lined up, this move could actually hurt a future application for credit. This is because frequent moves mean that you’re not in a specific country long enough to establish a credit history, one of the first aspects lenders look at when assessing a candidate. For someone who likes to move frequently, whether through work or not, this makes it near impossible to get credit products like a mortgage.

Situations like those listed above, often result in a catch-22 for millennials; if they can’t get finance, then it is difficult to build a credit report. Without a good credit report, it is difficult to get finance. The reality is that credit bureaus simply do not have enough information about millennials and they take this as a bad sign. Typically millennials do not use banking services in the same way as previous generations, which makes it difficult for outdated credit bureau models to make a fair evaluation of an individual.

The problem perpetuates poor spending behaviours.

In general poor risk assessment models create unfairness for the non-traditional borrower. Clients that use banking in non-traditional ways end up being quoted higher prices for several reasons. Firstly, some of the clients with a high probability of defaulting are not caught by the models. Secondly, groups using banking in non-traditional ways or that have moved around a lot are labelled as high risk, even if they have a good salary and are responsible with their spending.

Lack of access to finance tempts many millennials to take high-cost ‘payday’ loans. Payday loans actually work against a credit score, dragging a score down each time someone gets a loan of this type. Many millennials may also be unaware that these types of records stay on a credit history for five years, which is a long time. Yet the relative ease of payday loans and lack of access to cheaper credit is a tempting near-term solution for this vulnerable generation.

“Their lack of a financial track record counts against [millennials] and often the only answer left for them is to take out credit products like payday loans which, whether we like it or not, is damaging to credit scores and their ability to climb the credit ladder to more affordable forms of finance,” says Carl Packman, a research manager at the charity Toynbee Hall.

Image credit: Anna Dziubinska

Millennials aren’t the only social groups which suffer from problems like these. Non-OECD countries also suffer from a lack of access to credit. An incredible two billion people worldwide still lack access to regulated financial services, most of whom are in the Global South. Inadequate access to credit cards and other credit services hinders growth because it limits opportunities to start and grow a business, create jobs, and even gain access to skills and knowledge. And as is the case with millennials, even if you have access to credit cards it doesn’t mean you can easily get one.

The social solution lies in alternative credit scoring.

Credit bureau’s current methods of assessing creditworthiness is a big problem for millennials and the underbanked, but there is a solution: alternative credit scoring.

The beauty of alternative credit scoring is that the approach is much fairer to groups such as young adults or those from underdeveloped countries. This is because alternative scoring is not biased by age, lifestyle choices or lack of history, but instead will use other, more readily available methods to assess risk. By providing better tools to financial institutions through new alternative scoring methods, lenders can offer cheaper rates because the risk is understood to a higher degree, which in turn will have a huge, beneficial impact on society.

For millennials, new methodologies will look more favourably on the lifestyle habits of this age group, making decisions for lenders easier by looking at alternative types of data. This will have a significant social benefit for this crucial age group, which are set to make up 50% of the workforce by 2020.

The role of lenders in the future is hugely important in driving positive social change.

New types of scoring methodologies go far beyond making decisions for lenders easier. As part of the digital transformation, it is vital to recognise the far-reaching social benefits of using alternative credit scoring and how these new techniques can be incorporated to make lending fairer for all. By providing lenders with more reliable, less risky tools to judge creditworthiness, we can all stand to benefit, society included.